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HOW I PICKED A SAAS STOCK

How I Picked A SAAS Stock

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Don’t Listen To Me, But Please, Hear Me Out: # 38

Shaheeda Abdul Kader, June 10 2021, Updated June 13 2021

How I Picked A SAAS Stock

I’ve been watching CRM (Customer Relationship Manangement) and SAAS (Software As A Service) stocks for a while. Here’s how I looked at 5 of them to decide which SAAS stocks to buy. If you follow me on twitter or you have read my previous blogs, you know that I like to pick a stock and hold for long time. Usually, between 3 and 10 years. My favorite tech stocks have all pared back their 2020 euphoric gains. So, is this a good time to buy? 

I have also wanted to own Salesforce stock for a long time. It is a great company, by far the king among CRM applications for large enterprises and even SME’s. A quick glance said, they look cheap, so shall I buy?

But of course, investment resources are limited. The question always should be if I have $10,000 to invest, where should I invest to get the biggest bang for my returns with lowest risk of losing my investments?

I looked at the following stocks to compare.

  1. Salesforce $CRM
  2. Adobe $ADBE
  3. Microsoft $MSFT
  4. Autodesk $ADSK
  5. Atlassian $TEAM
 CRMMSFTADBEADSKTEAM
Company NameSalesforce.com, inc.Microsoft CorporationAdobe Inc.Autodesk, Inc.Atlassian Corporation Plc
SectorInformation TechnologyInformation TechnologyInformation TechnologyInformation TechnologyInformation Technology
IndustryApplication SoftwareSystems SoftwareApplication SoftwareApplication SoftwareApplication Software
Market Cap218.92B1.91T244.07B61.31B57.50B
Enterprise Value210.18B1.87T243.82B62.48B56.63B
Employees56,606163,00022,51611,5006,117
SA Authors Covering816922
Wall St. Analysts4739282022
Fig 1: Market Cap. Source: Adapted from Seeking Alpha

Microsoft is the biggest company with a market cap of $1.9 Trillion followed by Adobe at $244 Billion, Salesforce at $219 Billion, while Autodesk and Atlassian are relative pups with a market cap of $61.5 Billion and $57.5 Billion respectively.

Look at the number of employees at each of the companies. Salesforce has over 56,000 employees whereas Adobe has less than half that at 22,500 employees. Adobe enjoys a higher market cap than Salesforce with less than half the employee strength.

Both Microsoft and Salesforce are part of the elite Dow Jones Index.

Selection Criteria

I wanted to look at stocks that meet some of the following criteria:

  • SAAS: All 5 offer SAAS solutions
  • CRM (Customer Relationship Management): 3 of them, Salesforce, Microsoft and Adobe, offer complete or partial solutions in CRM.
  • Collaboration Tools: SalesForce, Microsoft, Adobe, AutoDesk, and Atlassian all have some sort of collaboration application. Atlassian’s main function is collaboration. Collaboration could be for sales and customer management, project and product design management, internal teams collaborations etc. You may recall that SalesForce purchased SLACK for nearly $28 Billion in 2020. Microsoft has Teams.
  • High Recurring Revenue from Subscriptions:  SAAS companies by design offer subscription services that translate to reliable monthly recurring revenues. High percentage of revenue for all these companies is from subscriptions. These make a company’s financial statements very strong and healthy. For example, 94% of SalesForce revenues is from subscriptions. When is the last time you thought about your Microsoft 365 Subscription? You probably have set it for autopay. In 2021, Amazon made $25 Billion from Prime Subscriptions alone. 

Is The Industry Growing?

Is the industry growing? SAAS, CRM are both growing industries.

The global software as a service (saasmarket is expected to grow from $225. 6 billion in 2020 to $272.49 billion in 2021 at a compound annual growth rate (CAGR) of 20.8%.

Global NewsWire, May 6 2021,

There is healthy competition from many companies who are not publicly traded. These are good signs that there is a growing and viable industry for smaller or newer players to take a punt.

What Do The Numbers Say?

As I explained in my last blog, we will look at the Financial Statements, some ratios, growth and profitability metrics.

Income Statement TTM

All the data below is TTM or Trailing Twelve Months. In other words, from the last 12 months.

What we can see immediately is that ADBE generating only 60% of the revenues that Salesforce does, has a higher market cap (See Fig 1 above). This is puzzling, so let’s keep this in mind.

ADBE leads significantly in both Revenue Per Share as well as Earnings Per Share or EPS.

ADBE also generate much higher profits with lover absolute revenues compared to Salesforce. Why do you suppose that is? Or What can we infer from this?

Income STMTCRMMSFTADBEADSKTEAM
Revenue22.35B159.97B13.68B3.89B1.96B
Revenue Per Share24.4521.1628.5017.747.88
EPS Diluted4.747.3411.495.84-3.49
Net Income4.44B56.02B5.57B1.30B-868.47M
Gross Profit16.61B109.39B11.97B3.58B1.65B
EBITDA3.48B75.58B5.33B755.10M139.23M
Operating Income949.00M64.23B4.75B662.00M105.88M
Net Income Avail. to Comm.4.44B56.02B5.57B1.30B-868.47M
Fig 2: Income Statement TTM. Source: Seeking Alpha

Balance Sheet Statement TTM

In the balance sheet, I want to see the followimg:

  • Cash and cash equivalents
  • Free Cashflow (FCF)
  • Debt

In other words, if everything goes pear shaped, do they have sufficient cash and cash equivalent assets to pay off all their debt obligations and survive?

See the table below. In general, we want the Current Ratio and Quick Ratio to be greater than 1. (I have described how to read a balance sheets here.)

Balance SheetCRMMSFTADBEADSKTEAM
Total Cash15.02B125.01B4.96B923.20M1.56B
Total Debt6.28B81.26B4.71B2.09B786.84M
Total Debt to Equity14.76%60.41%34.75%185.32%190.67%
Short Term Debt
Long Term Debt2.67B50.01B4.12B1.64B
Current Ratio1.332.291.270.480.78
Quick Ratio1.192.101.120.400.69
Debt/Free Cash Flow0.331.320.881.23
Long Term Debt/Total Capital11.30%32.71%25.27%62.59%17.14%
Fig 3. Balance Sheet TTM. Source: Seeking Alpha

As you can see, Autodesk ($ADSK) seems to have the weakest balance sheet. It carries 1.23 times debt compared to the Free Cash Flow (FCF) it generates. The Current and Quick ratios are less than 1, which means they do not have enough cash to pay off their obligations if the business should take a bad turn. Of course, these are numbers to think about. It does not mean that ADSK cannot be a good investment. We will look at growth rates to understand why.

Moreover, since interest rates are very low, it may actually benefit companies to borrow more. Counter-intuitively, certain long-term debt may actually help reduce the company’s overall cost of capital.

Cashflow Sheet Statement TTM

In the cashflow statement, we want to look at Cash from Operations and FCF. By the way, Tesla selling bitcoin for profit and generating cash DOES NOT qualify as cash from operations. Cash from operations must be from the company’s stated business. It must arise from selling its products and services. Selling Bitcoin is cash from financing activities for Tesla.

Levered FCF is cash leftover after a company pays off all its financial obligations.

Cash Flow StatementCRMMSFTADBEADSKTEAM
Net Operating Cash Flow6.17B72.70B6.17B1.45B780.30M
Levered Free Cash Flow8.20B37.78B4.69B1.34B836.43M
Cash from Operations6.17B72.70B6.17B1.45B780.30M
Capital Expenditures-558.00M-18.91B-384.00M-91.50M-38.57M
Fig 4: Cashflow Statement TTM. Source: Seeking Alpha

You will notice a peculiarity. Salesforce has a Net Operating Cashflow of $6.17 Billion but a higher Levered FCF of $8.2 Billion. Puzzling right? Especially since Salesforce has such a low margin. Well, turns out Salesforce’s venture arm is extremely good at picking winners. In March 2021, Salesforce reported a $2.12 Billion Annual gains from its tech investments. Some of these are Zoom, nCino, Snowflake, Auth0 etc.

I am wondering if Salesforce should Pivot to being a Venture Company? Or better, should I compare Salesforce to VC’s such as Sequoia, Khosla Ventures, Tiger Global etc., rather than SAAS companies?


Growth Rates

This is where Salesforce really shines. Any company that can show a compounded annual growth rate of 10% or more is worth considering for investments.

You can see that all 5 are stars in this arena.

Microsoft is the oldest and biggest company, so their growth is impressive. It is harder to double $1 Million to $2 Million than it is to double $1,000 to $2,000.

GrowthCRMMSFTADBEADSKTEAM
Revenue Growth (YoY)22.63%15.34%17.33%13.71%29.10%
Revenue Growth (FWD)21.96%13.80%16.55%16.47%24.98%
Revenue 3 Year (CAGR)26.09%14.75%21.13%22.26%34.33%
EBITDA 3 Year (CAGR)35.90%1 9.70%25.11%NMNM
Net Income 3 Year (CAGR)84.87%52.59%43.63%NMNM
Levered FCF 3 Year (CAGR)43.68%22.53%25.34%89.99%45.08%
Fig 5: Revenue and Income Growth. Source: Seeking Alpha


Profitability Rates

While it is the Venture Capital command to grow at any rate without worrying about profitability, I care very deeply about profitability. If a company is not profitable, but I can see a clear path to its profitability, then I will consider investing in this company.

 CRMMSFTADBEADSKTEAM
Net Income Per Employee74.32%68.38%87.45%91.95%84.28%
EBIT Margin4.25%40.15%34.75%17.00%5.40%
EBITDA Margin15.55%47.25%38.98%19.39%7.10%
Net Income Margin19.87%35.02%40.68%33.32%-44.31%
Levered FCF Margin36.71%23.62%34.25%34.33%42.67%
Return on Equity11.52%44.99%46.36%262.27%-140.89%
Return on Assets1.00%13.51%12.86%6.44%1.90%
Return on Total Capital1.32%19.38%17.78%16.02%4.17%
Cash From Operations6.17B72.70B6.17B1.45B780.30M
Revenue Per Employee375.44K877.39K571.50K329.60K328.95K
Net Income Per Employee78,472.25343,650.31247,201.99112,808.70-141,975.64
Fig 6: Profitability. Source: Seeking Alpha

Microsoft clearly hits it out of the park with profitability. It has amazing margins. Even with a huge workforce, each of Microsoft’s employees generate a whopping $877,000 in revenue and $343,000 in net income or profit.

Contrast this with Salesforce. Even thought Salesforce enjoys a great gross margin of 74%, its net margin is a paltry 4.25%. You can also see that Salesforce is far behind in both revenue and profit generated per employee. Some analysts argue that Salesforce is like Amazon in 2000’s, in that, Salesforce is investing back in it is infrastructure and building a huge moat. Salesforce spent a lot in large acquisitions and these will pay off over time. Only time will tell.

Adobe looks great in comparison. But then yesterday, I came across a company called, Photopea, built and run by a Single Founder. Photopea generated $500,000 in revenues last year. It mimics entire Photoshop suite and is FREE. The founder, Ivan Kuckir, earns his entire income for Photopea from ads.

So, I worry about the completion when it comes to Salesforce as its margins are very low. It however does have a healthy cash position of $15 Billion.

What Is Cheap To Buy?

Now that we looked at the financial health and growth factors, we must answer the all important question. Is it cheap to buy? What is a good price to buy? In other words let’s look at the valuation.

ValuationCRMMSFTADBEADSKTEAM
P/E GAAP (TTM)49.7834.4244.8147.21NM
Price/Sales (TTM)9.6611.9418.0615.5329.46
EV/Sales (TTM)9.4011.6817.8216.0428.89
EV/EBITDA (TTM)60.4724.7145.7282.74406.77
Price to Book (TTM)5.1314.1518.2053.71141.40
Price/Cash Flow (TTM)35.4326.1639.9641.9274.78
Fig 7. Valuation. Source: Seeking Alpha

None of them are classic value stocks as their Stock Price To Earnings or P/E are all fairly high.

However, among them, Salesforce looks the cheapest as it is trading for less than 10 times its total sales. Microsoft also looks good as its Price/Sales ratio less than 12.

When To Buy?

We can never time the market, but we can make some educated guesses based on historical prices. For example, we can look at the Simple Moving Average (SMA) price over certain periods or the Exponential Moving Average EMA price over certain periods.

 CRMMSFTADBEADSKTEAM
Last Close$236.42$252.57$509.20$278.66$228.93
52 Week High$284.50$262.58$536.88$321.13$262.40
52 Week Low$171.27$182.25$387.37$215.83$160.01
Price vs. 52 Week High-16.90%-3.81%-5.16%-13.23%-12.76%
Price vs. 52 Week Low38.04%38.58%31.45%29.11%43.07%
Last Price236.42252.57509.2278.66228.93
SMA % (20D)3.67%1.62%2.57%-0.58%1.88%
SMA % (50D)4.43%0.59%1.94%-2.40%1.18%
SMA % (200D)1.01%10.44%5.33%2.13%5.35%
Fig 8: SMA. Source: Seeking Alpha and Koyfin

Salesforce seems like it is the best priced to buy right now because it is nearly 17% below its 52 week highs and it is only 1.01% above the 200 day simple moving average price. However, it is still 38% above its 52 week low.

Microsoft doesn’t seem to be a bargain at this time because its also 38% above its 52 day week low and 10% above its 200 day SMA.

However, I believe all these 5 companies have good growth stories and depending on your risk appetite, you can take a small position and build it over time.

Final Thoughts

After reading several articles and analyses, I personally favor Microsoft and Adobe. They both have great growth prospects, solid margins as well as healthy balance sheets. My goal is to invest in good companies that have excellent growth potential and lower risks.

I will add to my Microsoft position as well as a take a small position in Adobe if there is a decent dip in price.

Salesforce is intriguing as I have been curious about Salesforce for a long time, especially since I have tremendous respect for its founder, Marc Benioff. However, I am not convinced their “infrastructure” spend and acquisitions are similar to that of the Amazon story. I worry that some of these acquisitions maybe like Peter Lynch says, “de-worsification.” I hope I will be proven wrong.

If you are starting out, I suggest starting with an index fund. You can read more about why investing in index funds such as $SPY is good in this blog.

Check the Resource Page to find all the articles and tools I used to prepare this blog.

I usually blog about investing in the stock market. If you would like help on how to budget, save or invest more, please feel free to reach me, on Twitter @saq3 or LinkedIn @Shaheeda Abdul Kader, or leave a message at say@shaheedasays.com. I’d be happy to offer you my services. Please do check my other blogs here.

Disclaimer:

I am NOT a certified broker or financial advisor. Please DO NOT make investment decisions based solely on my blogs. My intention is to show you how to research stocks or funds for yourself . I hope you will be empowered and knowledgeable to do your own investigations and invest with confidence. It is best to consult with your broker or advisor if you have questions. You can also reach me, and I’ll do my best to help you with your queries.

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Shaheeda Abdul Kader

After 25 years of working for corporations, being an entrepreneur and managing investments for my family, I now want to help others find their financial freedom